Sandhill delivered a very good quarter to its clients.
The Concentrated Equity Alpha (CEA) composite returned +9.4% net of fees vs. a return of +7.2% for the Russell 3000 Total Return Index.
The Corporate Bond composite returned +2.8% net of fees vs. a return of +2.2% for the Bank of America Merrill Lynch 3-5 Year Corporate Bond Index.
The Large Cap Yield (LCY) composite returned +1.7% net of fees vs. a return of +0.4% for the Dow Jones Industrial Average.
The Private REIT that we distribute had no change in its equity price and maintained its dividend – a good result given the rapid rise in interest rates.
The new Preferred Equity composite had a positive return of 4 basis points in the first quarter which is a good result given the tremors in the banking system and the increase in interest rates.
I am extremely pleased with Sandhill’s results and execution in the first quarter.
I would like to ask our investor base to not get too focused on short-term performance. This is a mistake. People become wealthy via the public markets from a combination of things:
First, it is the power of compounding plus time. This is the most powerful wealth builder.
Second, it is sticking with the game plan. Find a talented money manager with good, well-thought-out products and stay with them unless there are lengthy performance “deserts”.
Third, own good underlying assets. That is, companies that have great products, distribution, innovation, and management, and most importantly, generate a ton of free cash flow that can be reinvested to grow the business.
Fourth, avoid mistakes and trouble. Assets that implode are the performance killers. Don’t chase the latest fad or trend. We all want companies that are at the leading edge of the innovation curve – but it has to be real – not hype. Think of all the recent trouble spots – and they were big trouble – crypto, long-term bonds, regional bank stocks – all caused meaningful capital loss to their owners. Sandhill avoided all of them (intentionally) – and I don’t think we get as much credit as we should.
Fifth, be tactical. For example, we were holding a lot of cash at the beginning of the year and put it to work when the market got sloppy in the middle of the quarter. Another example of tactical and intentional investment is the last nine months have been a great time to buy bonds as interest rates rose dramatically and spreads widened – Sandhill has been an aggressive bond buyer over the last nine months.
If you wrap all of this together, performance can be a limiting factor in determining good outcomes. For example, in a balanced portfolio, does Sandhill get credit for staying very short on the yield curve when exposure to long-term bond products would have yielded disastrous results? The answer is no. Three significant banks went broke in the first quarter because they were caught with too many long-term bonds on their balance sheets. Another example: In the depths of the recent bear market, did Sandhill get credit for sticking with growth stocks over value stocks? The answer is no. And, as we thought, quality growth stocks came roaring back in the second half of 2022 and Sandhill’s CEA product outperformed in calendar 2022 and the first quarter of 2023. By sticking to our game plan, we came out ahead, but we lost some business in the process. I have emphasized over the years the importance of discipline in effecting good investment outcomes.
Finally, Sandhill is built to perform. But good performance is neither short-term nor linear. There will be periods of good performance and periods of underperformance. The only thing that matters is that our clients hold quality assets that will retain/realize their value and Sandhill delivers outperformance over the long haul. This is what we expect from ourselves and is our deliverable to our clients.
As I mentioned, CEA had a terrific quarter. More importantly, I like our portfolio right now. You will notice that the turnover in our portfolios has dropped to almost nothing. This is generally a good sign. In late 2021 and early 2022, we sold lesser quality companies, companies that had too much debt, and companies where we could not find a clear line to operational success. Simply, we have reinstituted capital discipline and that is reflected in our results.
We have done a great job with our Corporate Bond product. We got really short on the yield curve a year and a half ago which mitigated a lot of the interest rate risk in our bond portfolios. Over the last year and a half (10/1/21-3/31/23), the United States has experienced the largest interest rate increase in nearly half a century. Over the same year and a half time period, our Corporate Bond composite has returned -4.5% net of fees. A really terrific job protecting our clients’ capital and avoiding permanent capital loss.
As I mentioned in the last newsletter, we pivoted to becoming bullish on bonds and lengthened the duration of the bonds that we were buying because we wanted to lock in the higher yields for a longer period of time. We feasted on the plump corporate yields and became fully invested in our bond portfolios in the first quarter.
We very much hope the interest rate cycle peaks in 2023. We have done our best to maximize our clients’ investment opportunities in this higher rate period by buying quality cash-flowing growth stocks, longer-duration corporate bonds, and preferred equities. If the interest rate cycle does peak in 2023, we are well positioned.
Our Preferred Equity product – our newest product – was launched in the late fall of 2022. The intention was to capture the higher yields in an elevated interest rate environment in a tax-advantaged way. All of the preferred equity dividends are qualified which implies a federal tax rate at the long-term capital gains rate. Good tax management and more after-tax cash flow yield to the client.
When designing the Preferred Equity product, we intentionally used no smaller regional banks as underlying credits which proved to be a very wise decision. The Preferred Equity product is volatile to both the up and the downside – but a current yield of 5.3% and a yield-to-call rate of 8.1% are too attractive to pass up. To be clear, this product has direct and complete exposure to the banking industry. That said, I don’t think credits like JP Morgan, Goldman Sachs, and Morgan Stanley (and others) are going anywhere soon. I am excited about the forward prospects of this product and think it is suitable for 5-10% of a client’s portfolio.
Finally, the industrial Private REIT that we distribute (and follow like any other holding of ours) is price and dividend stable in what has been a bad environment for REITs in general. Since REITs (this is a broad generalization) normally get half their funding from equity and half from debt, a rapidly rising interest rate environment is not friendly to the REITs. The upside to this is that higher interest rates should present more attractive buying opportunities for the REITs as cap rates increase. The Private REIT’s industrial and commercial properties are 100% occupied with long-lived leases and 100% rent paying. The Private REIT will be a good place to return should interest rates decline as they have over the past month. The tax advantage of the Private REIT’s tax-sheltered dividends is very attractive.
Rick Ryskalczyk has been promoted to Co-Managing Partner. This is a well-deserved promotion and I am thrilled for Rick. Rick has worked at Sandhill for twelve years. He is a Senior Partner and co-heads the investment team along with me. Rick will be joining Shant Goubrial as Co-Managing Partner in running the firm’s day-to-day operations and setting forward corporate strategy.
I will remain as lead Portfolio Manager, Partner, and majority owner. I remain fully committed to Sandhill and the outcomes we produce for our clients.
Assets under management and advisement were $1.92 billion as of 3/31/23. Assets under management and advisement increased by $87 million during the first quarter of 2023.
I know that we have a number of concerned clients out there. Investors read the daily headlines and extrapolate the world’s problems to the behavior of our capital markets. Fair enough. It is a dangerous world out there with the velocity of information (and misinformation) skewing the way we view the world. But remember, the stock market is smarter than all of us and brings no emotion to the game. The valuation of the stock market is directly correlated to corporate earnings and interest rates. It is the arc of human emotion that causes many of the wild market swings that the capital markets experience. It is this volatility that creates these great investment opportunities.
I am cautiously optimistic for the first time in a while. The greatest bullish carrot out there is the end of the interest rate increase cycle and a more benign rate environment. This would be really constructive for the stock and bond markets. The bearish clouds out there are equity valuations remain high and the possibility that inflation reaccelerates. The wild card out there is the Ukraine-Russian war – its end would ease both food and energy inflation and more importantly, end the unfathomable misery cast on so many.
I hope the advent of spring finds everyone well.
With warm regards,
Edwin M. “Tim” Johnston III
Annualized Performance Summary (Net of Fees) As of 3/31/2023
CEA (Master): 1 Year: 0.2% | 5 Year: 7.5% | 10 Year: 12.0%
Russell 3000 TR: 1 Year: -8.6% | 5 Year: 10.5% | 10 Year: 11.7%
Corp. Bond: 1 Year: -0.2% | 5 Year: 1.9% | 10 Year: 2.5%
B of A ML 3-5 Year: 1 Year: -1.1% | 5 Year: 2.1% | 10 Year: 2.1%
Large Cap Yield: 1 Year: -3.8% | 5 Year: 8.1% | 10 Year: 8.1%
DJIA: 1 Year: -4.1% | 5 Year: 6.7% | 10 Year: 8.6%
Preferred Equity (Cumulative): 0.9%* [since inception]
Invesco Variable Rate Preferred ETF (Cumulative): 0.7%* [since inception]
*Please note: Inception date of Preferred Equity product is 11/30/2022
This report has been prepared for informational purposes only and is neither a solicitation to buy or sell securities. Third-party information in this report has been obtained from sources believed to be accurate; however, Sandhill makes no guarantee as to the accuracy or completeness of the information. Sandhill Investment Management (“Sandhill”) is a registered investment adviser with the Securities and Exchange Commission that is not affiliated with any parent company. Individual results may vary. Investments may not be suitable for all investors. Performance may be materially affected by market and economic conditions. Investment strategies have the potential for profit or loss. The U.S. dollar is the currency used to express performance. Performance presented net-of-fees is reduced by investment management fees, trading expenses, and administrative fees. Interest, dividends and capital gains in these Composites are not immediately reinvested. The Concentrated Equity Alpha Composite includes all discretionary non-wrap fee paying accounts in the all-cap core strategy which may hold large, mid, and small capitalization U.S. common stocks, American Depositary Receipts (A.D.R.’s), domestic ETF’s, sector ETF’s, and cash. The Russell 3000 TR Index is a market cap-weighted index of 3000 of the largest US common stocks which represents 96% of the US equity market. The Large Cap Yield Composite consists of all discretionary non-wrap fee accounts invested in U.S. common stocks, American Depositary Receipts (A.D.R.’s), domestic ETF’s, sector ETF’s, and cash in solely large capitalization companies. The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ. The Corporate Bond Composite consists of all discretionary non-wrap fee paying accounts invested solely in individual Corporate Bonds and cash equivalents. The Corporate Bonds will generally be rated single B to single A and will have maturities of three to nine years. The Bank of America Merrill Lynch 3-5 year Corporate Bond Index is a subset of the Bank of America Merrill Lynch US Corporate Master Index tracking the performance of US dollar denominated corporate debt publicly issued in the US domestic market. The Preferred Income product’s primary goal is to provide current income with secondary objectives of total return and tax efficiency. The Preferred Income product will primarily buy Preferred Equity but maintains the flexibility to hold other hybrid instruments such as Convertible or Baby Bonds. Holdings may be either investment grade or high yield. The Primary benchmark is the Invesco Variable Rate Preferred ETF (VRP). VRP seeks to track the investment results of the ICE Variable Rate Preferred & Hybrid Securities Index. The fund will invest at least 90% of its total assets in the components of the index, as well as ADRs that represent securities in the index. The index provider compiles and calculates the index, a market capitalization weighted index designed to track the performance of floating and variable rate investment grade and below investment grade U.S. dollar denominated preferred stock, as well as certain types of hybrid securities. It is non-diversified. VRP performance is reported net of the 50bps expense ratio based on closing market prices. VRP is the only above referenced benchmark available for direct investment. For a full performance presentation and/or the Firm’s list of composite descriptions, please call 716-852-0279.
Private REIT Disclosure: Accredited investors only: Non-Traded Private REIT is only offered and sold to individual investors and certain entities which are “accredited investors” under the Securities Act and the rules of the SEC, and who provide us with information we require to verify their status as accredited investors. Individuals are accredited investors only if they meet certain minimum net worth or sustained annual income thresholds. Entities are accredited investors only if they hold sufficient assets or are completely owned by accredited investors. Limited Liquidity: Investors may need to hold their shares for an indefinite period. REIT’s dividend is comprised of ordinary income (taxable) and return of capital (tax deferred). For income tax reporting via form 1099, real estate investments benefit from certain non-cash tax deductible expenses (i.e. depreciation). You should obtain financial and tax advice and conduct diligent investigation of information material to you before making any investment decision.
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